[Viewpoint]To achieve growth, reduce debt first

Skyrocketing consumer debt due to frenzied real estate investments have put a growing burden on Korean households.
As of the end of last year, the amount of personal loans secured by real estate collateral-backed loans made by banks amounted to 217 trillion won ($235 billion), a 14 percent increase over last year. The Bank of Korea published a financial stability report on Thursday saying that since the grace period for repaying the principal for home mortgage loans will mostly come due in 2009, the amount of repayment costs in principal and interest are expected to increase about 22 percent in 2010 ― from 13.7 trillion won to 16.7 trillion won.
Interest rates have rapidly increased and the ratio of interest payments to total disposable household income has reached its highest point in seven years.
The ratio, which had jumped from 6.28 percent in 2004 to 7.78 percent in 2005 and then to 8.64 percent in 2006, was much higher than that of the United States and Japan, which recorded 7 percent and 4.7 percent respectively. Since it is said the ratio will further increase to 9.5 percent by 2010, it is inevitable that the ability of Korean households to pay back their debts will deteriorate even more. Despite the fact that household debt is climbing, Korean households are not able to respond to the quickly changing conditions of the financial market because their assets are mostly real estate (76.8 percent).
The ratio of household debt to financial assets, a barometer of consumers’ capacity to pay their debts without selling off assets, came to 44.4 percent at the end of last year, up from 43.2 percent a year earlier ― meaning households’ ability to pay their debt is slowly getting weaker.
Interest and principal payment costs are growing quickly because debts are increasing faster than income and financial assets, people have begun to express concerns about the stability of the household economy. As people’s anxiety continues to increase, there is even talk that a financial crisis might occur due to household debt insolvencies.
However, considering the improvement in the financial companies’ ability to respond to such insolvencies, it is not likely that losses from overdue loans, which can be caused by a sharp drop in apartment prices or big increase in interest rates, will lead to overall instability in the financial market.
That is, the possibility of a financial crisis originating from growing household debt is very low. Especially, as the loan-to-value ratio that is applicable to home-backed loans is only 49.3 percent, there is a very low possibility that a household debt increase caused by insolvencies will lead to the worst-case scenario ―asset sales at auctions.
In the past, home-backed loan regulations were focused on reducing the amount of the loans. Therefore, there are many loopholes in the loan system, such as the lengths for maturity, methods of redemption and interest rate conditions. Accordingly, the government had tried to induce people to change short-term loans to long-term ones that mature over 10 years and to redeem principal and interest in installments, so the repayment burden would not be concentrated in a short period of time. Although it came belatedly, it is fortunate that the shock to the household sector, which could occur when the repayment burden had to be concentrated in a short period of time, can be alleviated.
Of course, the financial authorities should exert sustained effort to block the possible outbreak of a financial crisis and closely watch the increase in the speed of household loan increases and the possibilities of a burst real estate bubble and household loan insolvencies. If the period of deferment in the current system of redemption in installments, which induces people to borrow more money than necessary by reducing the burden for redemption at the time of the loan, is abolished, household loans will get more sound and manageable.
It is necessary for the financial authorities to improve government policies, but what is essential more than anything else is that individual households try hard to reduce debts. In a structure where the power of consumption dwindles while debts increase, the best economic principle that households should pursue is nothing but reducing debts. Instead of expecting the government to reduce interest rates and cut the tax burdens, it is time for each household to restore the soundness of its own assets.

*The writer is the chief research fellow in charge of the Macroeconomic Research Division of the Korea Institute of Finance. Translation by the JoongAng Daily staff.

by Shyn Yong-sang